3 Scale and scope of Scottish income tax powers

This chapter sets out the extent of the Scottish
Parliament’s income tax powers, the relevant tax base (i.e.
where tax can be raised from) and the interactions with powers held
by the
UK Government and
Westminster Parliament. It also provides comparative information on
the tax systems of other countries.

3.1 The scope of income tax powers and their interactions
with reserved matters

“Scottish income tax cannot be considered in
isolation because the powers are only partly devolved. The tax is
intricately interwoven with UK taxes, and the Scottish Parliament
has only a limited number of pieces of the jigsaw.
[3]”

The Scottish Parliament does not have a full set of policy
options available when it comes to taxation. Given the current
fiscal settlement, there are a number of interactions with reserved
systems that affect tax policy options in Scotland.

Non-Savings, Non-Dividend Income Tax

The Scottish Parliament has the power to set rates and bands for
non-savings, non-dividend income tax only. This is largely earned
income (e.g. from employment and pensions) and so for any income
people get from savings or dividends the rates are still set by the
UK Government and that
money goes to
HM Treasury and forms part
of the
UK budget.
[3]

As a result, there are flexibilities that the
UK Government can
exercise over income tax that are not available to the Scottish
Parliament. For example, the Scottish Parliament cannot use income
tax to incentivise savings or equity investments in new companies.
Any changes could also raise the risk of tax avoidance if people
were able to switch income from salary to dividends or vice versa.
This would both reduce the amount of tax paid overall and also mean
payments are made to the
UK Government as opposed
to the Scottish Government.

Allowances and reliefs

The
PA is the amount that
taxpayers are able to earn before they pay income tax. It is
determined by the
UK Government. The
Scottish Government can set a zero rate of tax, but unlike for the
PA, we cannot easily
remove the benefit of this policy from the very highest earners.
[4]

The power to create new tax allowances and reliefs remains
reserved. Again, this limits the fiscal levers available to the
Scottish Parliament. So, for example, the Scottish Parliament could
not provide further income tax relief for individuals who wish to
invest in enterprise (such as via
HM Treasury’s
Enterprise Investment Scheme) and the Scottish Government bears the
risk of any lost revenue from reliefs if they impact on Scottish
taxpayers more than in the rest of the
UK.

National Insurance and social security

Income tax is inextricably linked with National Insurance and
social security.

National Insurance (
NI) is a tax payable
by employees, employers and the self-employed on earnings and
profits. It is entirely reserved to the
UK Government. As a
result, any changes in Scottish income tax rates and thresholds
could lead to unintended anomalies for taxpayers when considered
alongside the
NI thresholds set by
the
UK Government. For
example, the threshold for the 2% rate of
NICs
has historically tracked the
HRT of income tax,
but since 2017-18 the
HRT in Scotland
has differed from the rest of the
UK. This means that some
Higher Rate taxpayers in Scotland continue to pay the Higher Rate
of
NI. The way to avoid
this impact would be for the Scottish Government to also have
control over
NI rates.

There are also interactions between income tax and reserved
social security powers. In particular, under
UK tax legislation,
income from certain social security payments, including the State
Pension, is liable to income tax. An increase in income tax,
therefore, could result in a decrease in net income for some social
security recipients. And in other cases, such as Universal Credit,
entitlement is determined by net (i.e. after-tax) income. As a
result, in making income tax decisions, the Scottish Government and
Parliament must be mindful of any unintended impacts on the income
of people in receipt of those payments, as the Scottish Parliament
does not have powers to legislate to mitigate them.

3.2 The Scottish income tax base

There are projected to be 4.5 million adults in Scotland in
2018-19 and 2.5 million income taxpayers. Around 2 million adults,
or 44% of the total number of adults, will not pay income tax as
they will earn less than the
PA.

As illustrated in Chart 1
[5] the large majority of taxpayers, around 2.2 million
individuals, will pay the Basic 20p rate of income tax. Around
346,000 individuals, or 8% of Scottish adults, also pay the Higher
40p rate, and only 20,000 taxpayers (or 0.4%) in Scotland pay the
45p rate.

Chart 1: Number And Proportion Of Adults In Scotland By
Their Marginal Rate Of Income Tax, 2018-19

The median income of taxpayers in Scotland is expected to
be around £24,000 in 2018-19

Looking across all Scottish taxpayers, i.e. those with taxable
earnings above the Personal Allowance, and including employees,
pensioners and the self-employed, the median income is estimated to
reach around £24,000 in 2018-19. This means that half of all
taxpayers in Scotland earn below this level. The highest income
groups can be set out as follows:

Highest income groups

Starting income

Top 25%

£36,000

Top 10%

£53,000

Top 5%

£70,000

Top 1%

£144,000

By comparison, the lowest income groups can be set out below.
For example, 10% of income tax payers in Scotland earn less than
£14,000, with 5% earning less than

£13,000.

Lowest income groups

Have income less than

Bottom 25%

£17,000

Bottom 10%

£14,000

Bottom 5%

£13,000

Bottom 1%

£12,000

Chart 2 shows the estimated income distribution of Scottish
taxpayers for 2018-19, split into quarters. This shows, for
example, that someone earning between £11,850 (the expected
level of the Personal Allowance next year) and £17,000 would
be amongst the lowest earning 25% of taxpayers in Scotland. For
illustrative purposes, various salary points are presented along
this scale too.

Chart 2: Estimated Income Distribution Of Scottish
Taxpayers, 2018-19

Higher and Additional Rate taxpayers account for nearly 60%
of all income tax paid Chart 3 groups Scottish taxpayers
according to the highest rate of tax they pay and also shows the
proportion of total income tax revenue that each group accounts
for. This highlights how, despite making up less than 10% of
adults, Higher and Additional Rate taxpayers account for 60% of all
income tax paid.

Chart 3: Contribution To Income Tax Liabilities By
Taxpayers And Band, 2018-19

3.3 Internationalcomparisons

International comparisons of tax systems are undertaken using
information compiled by the Organisation for Economic Co-operation
and Development (
OECD)
[7] (see Box B).

Box B: What do other income tax systems look
like?

Countries have made different choices about the number of
tax bands, tax rates and the progressivity of their tax
systems.

There is significant variation in how countries design their
income tax systems. Broadly speaking, the more tax bands a system
has the more progressive it is, as tax is more closely linked to
ability to pay. Scotland currently has three bands. The majority of
OECD
countries have more tax bands. For example, New Zealand and the
Netherlands have four, Belgium and Norway have five and Japan and
the
US have seven bands.

However, the number of bands is not a definitive measure of the
relative progressivity of a tax system. For example, Denmark and
Sweden have only two bands at the central government level, but are
still seen as broadly progressive. This is partly because Denmark
and Sweden apply their top marginal rates (55.8% and 60.1%
respectively) including local taxation on a relatively large
proportion of higher earners.

A few countries have flat rate systems where everyone pays the
same tax rate - this is not progressive (although the overall
system could be progressive depending on how spending is
targeted).

When considering income tax as a proportion of Gross
Domestic Product (
GDP), the
corresponding level of public spending is also
important.

Tax is only one side of the equation, as taxpayers also benefit
from public services. Generally, lower tax countries, such as the
US, also have lower public
spending as a proportion of
GDP and vice
versa for higher tax countries. Therefore, people with the same
level of income but facing different tax rates may still achieve
the same quality of life if the higher tax country uses these extra
tax revenues to fund public services rather than expecting the
individual to meet their own costs. In this context it is important
to note that Scotland has a much greater level of universal
provision of services than the
UK as a whole.

Scotland’s overall tax as a proportion of
GDP is below
the
OECD
average.

If we look at tax as a proportion of
GDP[8] across 31
OECD
countries in 2014,
OECD
figures show that the overall tax take in Scotland as a proportion
of
GDP (including
oil and gas) is below the
OECD
average. Looking at income tax as a proportion of
GDP,
Scotland’s figure (7.2%) is lower than the
UK’s (8.6%), partly
due to the concentration of high income earners in London and the
South East of England.
[9]